Overcoming the Bubble Economy

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Dean Baker
TomPaine.com, October 12, 2004

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Former Treasury Secretary Robert Rubin took the budget from deficit to surplus at the expense of America's working families. George Bush has taken the budget from surplus to deficit at the expense of America's working families. Sure, Rubinomics is better, but it just isn't good enough. Dean Baker says Kerry has to address more than just Bush's deficits; he must tackle pensions, the dollar, housing and, most of all, health care.

When it comes to the economy, George W. Bush is much better at creating excuses than jobs. Having lost nearly one million jobs since taking office, President Bush is the first president since Herbert Hoover who actually lost jobs during his term in office. This job loss has been accompanied by falling family incomes, a growing number of uninsured, and in the last year, falling real wages. At the same time, household debt and foreign debt, measured relative to income, have soared to record highs. In the language of Arnold Schwarzenegger, this is a "girlie-man" economy.

Almost anything looks good in comparison to the last four years, but voters still want to see a positive economic agenda from John Kerry. If he is to present such a vision, Mr. Kerry may want to consider diversifying his economic plan beyond the policies associated with former Treasury Secretary Robert Rubin.

Mr. Rubin was responsible for two of the biggest economic policy mistakes in this country in the last century. He let the stock market bubble inflate to unsustainable levels, and he promoted a policy of having an over-valued dollar. Both policies created an illusion of short-term prosperity. In the case of the stock bubble, millions of people felt very rich when they saw the NASDAQ at 5000. Similarly, an overvalued dollar meant cheap imports and helped to contain inflation. But in both cases, the temporary prosperity came at a high price.

It was inevitable that the stock bubble would burst and the crash was the cause of the 2001 recession. The crash destroyed much of the savings of older workers, forcing them back into the workforce in record numbers. It has also jeopardized the health of traditional pension plans. Several major pension funds have already collapsed and many others are in precarious condition, threatening the Pension Benefit Guarantee Corporation with bankruptcy. The stock market crash has also exposed much of the corporate corruption that flourished in the irrational exuberance of the boom.

The damage from the overvalued dollar threatens to be even more dangerous. With President Bush largely maintaining the high dollar policy, the trade deficit and foreign debt have continued to rise at a rapid pace. The current account deficit hit an incredible $660 billion in the most recent quarter, more than 5.7 percent of GDP. This deficit will push total foreign debt to more than $3 trillion by the end of this year. On its current path, it will exceed $7 trillion—approximately 50 percent of GDP—by 2009.

For now, the U.S. trade deficit is being generously supported by foreign central banks—primarily the Japanese and Chinese central banks. But when these governments can think of something more creative to do with their money than holding trillions of dollars at near-zero interest rates, then the dollar will plunge, and we will have to pay far more for imported goods and services. This will translate into higher inflation and a lower standard of living.

Kerry has quietly indicated that he would address the problem of an overvalued dollar. Instead, he should be aggressively attacking Bush for a policy that costs us jobs today and threatens the health of our economy tomorrow.

Unfortunately, the pension shortfall and the dollar bubble are not the only imbalances threatening the economy. The country also faces the most serious housing bubble in its history. While house prices ordinarily move in step with inflation, in the last nine years they have risen by almost 40 percent after adjusting for inflation, creating $4 trillion in bubble wealth.

This run-up in home prices has sustained the limited recovery we have seen over the last three years. Just as alcoholics attempt to cure one hangover by starting on the next, Alan Greenspan sought to contain the fallout from the bursting of the stock bubble by actively promoting the housing bubble.

The run-up in home prices has fueled growth both directly, by pushing housing construction to near record levels, and indirectly by allowing a massive wave of borrowing against home equity. This borrowing has fueled a surge in consumption, maintaining high demand for everything from cars to vacations.

Of course, the surge in borrowing has also meant record levels of debt. At a time when much of the baby boom generation is approaching retirement, the ratio of mortgage debt to home equity is at a record level—and this is even before the housing bubble bursts.

While it is impossible to predict the timing, just as with the stock bubble, there is no doubt that the housing bubble will burst. The extraordinary construction rate of the last few years has already led to record housing vacancy rates, and it is only a matter of time until this surplus supply pushes prices downward. When it does, the next president will be facing another recession, in addition to a financial crisis resulting from record mortgage default rates. Kerry’s team should be planning for this crisis and warning of it openly, so his administration doesn’t get the blame for the bursting of the Greenspan-Bush housing bubble.

In addition to planning for wreckage from the bubble, Kerry should have a positive agenda that engages America’s hopes and dreams.

At the center must be real health care reform. The U.S. health care system is a massive cancer that threatens to destroy the economy if left in its current form. We already pay more than twice as much per person as other rich countries, yet we have worse health care outcomes. And the costs are growing rapidly. The horror stories of $70 trillion budget deficits that the pundits like to tout are driven almost entirely by the projected explosion in health care costs.

The very clear and present threat of collapsing pensions, a falling dollar, and a tanking housing market combined with rising health care costs and the Medicare imbalance provides Kerry with an opportunity to build a sustainable growth path that allows for broadly shared prosperity. Kerry’s team should be looking forward to this new era by fielding a comprehensive economic vision, not a narrow one.


Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.